NFTs – Not For Today?

At some point in late 2021, someone sent me a link to a JPEG of a cartoon ape and suggested, with apparent sincerity, that I might want to buy it. Not a print of it. Not a framed reproduction. A cryptographically signed claim to the original digital file, which I could then look at on my screen in a manner entirely indistinguishable from simply right-clicking and saving it. The asking price was, at the time, somewhere in the region of a reasonable family car.

I did not buy the ape.

This is my attempt to explain why, in a way that goes slightly beyond "it seemed like a bad idea," because I think the question of NFTs deserves a more rigorous examination than it usually receives, buried as it typically is under either breathless enthusiasm or reflexive dismissal.

 

What NFTs Actually Are, and What Gives Them Value

An NFT, or Non-Fungible Token, is a unique entry on a blockchain that records ownership of something. Usually a digital file. The blockchain record is genuine and tamper-resistant. The ownership is real in the sense that the ledger says so. What it doesn't give you is exclusive access to the underlying file, copyright over it, or in most cases any legal rights whatsoever beyond a record that you paid for this particular token.

The value of an NFT is derived almost entirely from what the marketplace is willing to pay for it. This sounds like an obvious statement, but it has significant implications. Unlike a company share, which represents a fractional claim on real assets and future earnings, or a piece of art, which has physical existence and potential resale through established markets, an NFT has value precisely and only because other people believe it has value. This is not unique to NFTs, to be fair. The same is broadly true of currency, collectibles, and the more exotic corners of the traditional art market. But the feedback loop is tighter and less forgiving.

If you're trying to assess whether a specific NFT has any prospect of holding its value, five questions are worth asking. Does it provide utility: access to something, membership of something, an experience that wouldn't otherwise be available? Is there a track record of sustained interest in this project, or is it a week old and currently being promoted by the same people who stand to profit from your purchase? Does the creator have genuine brand recognition, or are they anonymous and hoping to accumulate some? Can you actually sell it when you want to, or will you discover that the market for this particular cartoon animal has quietly evaporated? And more broadly: are people actively buying similar assets for reasons that will persist, or are they buying because everyone else seems to be buying?

Most NFTs, evaluated honestly against those five questions, do not fare well.

 

Lazy Minting and the Blockchain Sleight of Hand

One detail that tends to get glossed over in NFT marketing is the widespread use of what's called lazy minting. The process of actually recording an NFT on a blockchain costs money in transaction fees. To avoid paying those fees up front, many creators defer the actual blockchain minting until the first sale, at which point the cost is passed on to the buyer.

The practical implication is that until someone buys it, a large proportion of NFTs being marketed aren't actually on the blockchain at all. They're promises of a blockchain entry, contingent on a sale occurring. You are being invited to pay for the privilege of making the thing you're buying actually exist. This strikes me as a slightly unusual sales model, even by the standards of an industry that has demonstrated considerable creativity in this area.

 

Why Most Projects Will Fail

In May 2022, as I'm writing this, there are tens of thousands of active NFT projects. New ones launch daily. The vast majority of them have three things in common.

First, they lack intrinsic value. They are, at their core, JPEGs. Sometimes procedurally generated JPEGs, where an algorithm has combined a selection of hats, backgrounds, and facial expressions to produce ten thousand slightly different versions of the same cartoon. The rarity of specific trait combinations is presented as a value driver, which it can be, but rarity in an essentially infinite digital space is an entirely manufactured concept. There is nothing preventing anyone from creating ten thousand more.

Second, the market is dramatically oversupplied. When the barriers to creating and listing an NFT are low, and the potential upside is high, the natural result is that an enormous number of people create and list NFTs. Supply and demand has not ceased to function simply because the asset class is new.

Third, most projects lack the sustained marketing effort, community building, and brand development that would be required to maintain value over any meaningful timescale. The projects that hold value, the Bored Apes of the world, have done so in part because of aggressive and sustained community cultivation. Most projects put far more energy into the initial launch than into everything that comes after it, at which point they are functionally competing with thousands of other projects for a finite pool of collector attention.

 

The Other Things Worth Knowing

The environmental cost is real and worth acknowledging. Proof-of-work blockchains, which underpin most NFT activity, consume substantial amounts of electricity. The exact figures are debated, but "comparable to a medium-sized country" is in the right general vicinity. Whether this bothers you is a personal calculation, but it should at minimum be a conscious one.

The technical complexity is a genuine barrier that the industry has an incentive to downplay. Many buyers have only a partial understanding of what they're purchasing, what rights it does and doesn't convey, how custody and transfer works, and what happens if the platform hosting the underlying file ceases to exist. The NFT you bought records ownership of a URL. What's at that URL is someone else's problem.

And the trend dependency cuts both ways. The same cultural velocity that drives a project's value up can reverse. NFTs exist in a cultural moment. That moment may persist, evolve into something more stable, or dissipate entirely. None of those outcomes is currently predictable with confidence.

 

The Honest Investment Position

I want to be clear that I'm not saying NFTs are fraudulent by definition. Blockchain-based ownership records have legitimate uses, some of which are beginning to emerge beyond speculative collectibles: event ticketing, provenance verification, access credentials for digital communities. The underlying technology is not the problem.

The problem is that the current market is overwhelmingly driven by speculation, and speculation requires a continuous supply of new buyers willing to pay more than the previous buyer. That supply is not infinite. When it slows, the assets that were purchased for speculative rather than utility reasons tend to lose value quickly, and the people who bought late tend to absorb those losses.

If you're considering putting money into NFTs, the most useful question to ask is this: would this still have value if the current hype entirely disappeared? If the NFT grants access to something genuinely useful or desirable that would remain desirable without the surrounding excitement, that's a more defensible position. If the value proposition is essentially "this is currently fashionable and I expect to sell it to someone who finds it more fashionable later," then you are speculating, and you should be honest with yourself about that.

Never part with more than you can afford to lose completely. That's not unique advice for NFTs. It applies to all speculative assets. But it applies with particular force here, because the distance between "this project is thriving" and "this project has no active buyers" can be measured in weeks rather than years.

I'll revisit this position if the landscape changes materially. Right now, in May 2022, the answer to the question in the title is: not for today. Possibly not for a while yet.

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